I know there are many dissenters of P2P lending. I personally only hold a small amount in it for numerous reasons named on several other threads and use Lending Robot for investing in the notes. P2P investing is more of a hobby of mine than a critical component of my investing plan.

I just received their newsletter and read http://blog.lendingrobot.com/opinion/ha ... ng-coffin/. For those who invest in P2P, does this (the trend of the increasing number of loans not available to the individual investor) concern you? I was planning on adding a bit more next year and then no longer contributing and just see how it does, but now I'm not sure.

I know this doesn't answer your question, but personally P2P Lending is dead to me. Granted I only put a small amount of money in to test the waters, but the results and experience has been sub-par to say the least. For the last two years, I think I barely broke even when factoring in my 30% default rate (with B and C loans). I know the pro-P2P people say you need to just invest more to see a better return, but sorry -- that just doesn't make sense to me.

I have two big issues with the way things work. The first is that even though I have had MANY late payers, including some loans that have paid late 10+ times, Lending Club has NEVER charged a late fee. Ever. Their documentation promises it as a way to recoup loss. And of course they levy a late fee on me. But when I challenged them on this, they said they often (always) waive the fee for the lendee to help encourage them to pay their monthly payment and they aren't obligated to enforce it. Even when payments were received 2-3 months late, there was still no fee applied. Sorry, but that just pisses me off.

The second, and obviously bigger concern, is that the ways these systems are structured means that if the lending company goes under, which is not an impossible situation, we have no equity in the notes that were issued and our investments are worth pretty much nothing. Which is why it boggles my mind that people would use anything but play money in this platform (for example, I would never consider opening up an IRA with them).

I've read a lot of reviews and there were many positive ones -- but most of those are quite old and from when these companies first came around.

j7se wrote:I know there are many dissenters of P2P lending. I personally only hold a small amount in it for numerous reasons named on several other threads and use Lending Robot for investing in the notes. P2P investing is more of a hobby of mine than a critical component of my investing plan.

I just received their newsletter and read http://blog.lendingrobot.com/opinion/ha ... ng-coffin/. For those who invest in P2P, does this (the trend of the increasing number of loans not available to the individual investor) concern you? I was planning on adding a bit more next year and then no longer contributing and just see how it does, but now I'm not sure.

In your shoes, I wouldn't take on more exposure.

I have read here about people trying to trade out of their loans, and that being made essentially impossible. Also despite the strong economy I don't think consumer defaults are behaving that well (check that with stats)? And there seems to be a body of borrowers on P2P who use it as a last resort. Also housing prices in some markets are looking toppy again.

The stock prices of the big P2P lenders are, I believe, way down. The market is taking a view re viability of those business models.

P2P lending should never be done by individuals IMO, way to much concentration risk and too much asymmetry in information.
Now with that said IMO it's an excellent asset class as alternative (not substitute) for safe fixed income. And I personally have a large investment in LENDX fund run by Stone Ridge. Basically you're paying them to run a P2P bank without all the infrastructure and regulatory regimes banks face, but one that still needs great credit people (note I was head of credit for the largest private mortgage company in country so I have lots of experience in this area), and not something individuals should be doing on their own IMO

larryswedroe wrote:P2P lending should never be done by individuals IMO, way to much concentration risk and too much asymmetry in information.
Now with that said IMO it's an excellent asset class as alternative (not substitute) for safe fixed income. And I personally have a large investment in LENDX fund run by Stone Ridge. Basically you're paying them to run a P2P bank without all the infrastructure and regulatory regimes banks face, but one that still needs great credit people (note I was head of credit for the largest private mortgage company in country so I have lots of experience in this area), and not something individuals should be doing on their own IMO

Due to limitations on tax advantaged space it's relatively small amount, but I sold ALL by CDs to invest. Expected return about 8% currently with just 2 year duration. So traded some credit risk for much less duration risk and about a massive premium which is mostly uncorrelated to equity returns except during periods of high UE. And if you stick to the non subprime in even in a period like 2008 with double digit UE net returns were around zero. It's in the subprime that you get massive losses.

I could see say 25% of fixed income in this space in a well run fund, or say 10% of total. But could take from equity side and have above market returns expected with about 1/4 of the vol and much less tail risk, then would consider taking even more.

But fund should be highly diversified, even globally. This is all about good risk management cultures.

I've written a white paper for our clients as we are beginning to implement in portfolios, so I might publish a version on line without going into the details of the specific fund too much.

Thanks Larry for the reply. I agree that lending shouldn't be done by individuals. I have been in Lending Club for a little over 5 years. The first 4 years I was managing my buys through the secondary market due to the fact that my state didn't allow buying on the primary. I was only averaging about 1% due to a high amount of charge offs. My state now allows buying in the primary and I switched to using LendingRobot. Their algorithms seem to be doing well compared to friends of mine who let Lending Club manage theirs. My primary market account is up 10% over 210 days. Whether that continues or not, I have no idea, though it seems unlikely from different blogs and posts I've read. My understanding is that institutional investors use something similar to cherry pick their notes.

I couldn't find much information on LENDX. What does that fund hold? What portion is P2P? You must have some faith in P2P lending's viability if that fund has any P2P holdings

Highlights:
--Expense Ratio: 3.74%
--"...the Fund will only sell shares to or through fiduciaries (such as RIAs or retirement plans) or institutional investors, or to employees, directors and affiliates of the Fund or the Adviser. The minimum initial account size is $15 million". So and an RIA fee onto the 3.74%.
--"Even though the Fund will make quarterly repurchase offers for a minimum of 5%, and currently expects to offer to repurchase 5%, of its outstanding Shares, investors should consider Shares of the Fund to be an illiquid investment". So you can only sell if they allow you to.
--"An investment in the Fund’s Shares should be considered speculative and involving a high degree of risk"

Sounds like a wonderful "opportunity".

Last edited by stlutz on Sat Dec 03, 2016 4:50 pm, edited 1 time in total.

I've averaged >7% return for years at LendingClub with >$100k invested among thousands of notes. I have another $50k in a real estate focused hard money P2P marketplace created by a few friends who are tremendous operators (and just raised a Series A from great Silicon Valley funds) that has been yielding >10%. I think over time if we can pick and choose (and ultimately diversify) our credit exposure to specific sectors - personal credit, auto, mortgages, hard money lending, etc - that is a good development for investors. You have to evaluate an investment relative to other opportunities out there. Overall in the current low yield environment I am content (not thrilled) with the performance from P2P given the risk. I do wonder how the businesses will adapt if/when rates rise a few points, which would make the risk/return profile relatively less attractive. But I guess credit card companies like Capitol One face this same challenge.

The SEC requires funds like LENDX and others like RiverNorth to include in expenses things that aren't fund expenses really, totally distorting the expense ratio of the fund. For example, if you dug into the information you would learn (just as example with rounding) the the services who originate the loan keep a servicing fee of say 1%. Let's say the gross yields were 14%, leaving net yield the fund receives at 13%. The SEC requires the fund, for no good reason since if the loans were securitized and they bought the security the SEC would not have them show the expenses of the servicer. But the outcome is the same. The fund earns 13% gross. There are other expense including the interest expense on the small amount of margin the fund uses, about 28%, which is used to try and recover the MANAGEMENT FEE it charges (not the listed expense ratio) which is less than 2% and is expected to drop bit further once the AUM increases, to about 1.75%.

Also the statement about RIAs feeding onto the 3.7 is absurd as the RIAs don't share in any fee. In fact, since they market through RIAs they keep distribution costs way down and don't need 800 numbers and have to deal with that.

As to repurchases, again you have this totally wrong. The fund is regulated by the SEC and all interval funds are required to allow investors to withdraw a MINIMUM of 5% per quarter. So basically can get out a minimum of about 20% each year. Likely far more. Now an investor can request 100% and get that, depending on other requests. But you can only run a fund that makes 3 and 5 year loans when you have capital that is committed. Hence one of the reasons for the high yield is the liquidity premium. Note the returns are tax inefficient and should be in IRA accounts where liquidity not an issue and even in RMD situation you don't get to 20% RMD till in 90s I believe. And of course this doesn't have to be all of your assets. This kind of complexity is exactly why it's not sold to retail investors.

Note this is not like buying an index fund of securities. Literally you are negotiating the purchase of entire slices of the originator's loans, providing the underwriting standards, and then carefully monitoring the originations DAILY. And it requires extensive due diligence ongoing and upfront to make sure credit cultures meet very high standards and are maintained. In effect, as I said you are buying a bank basically, without the infrastructure. That's why the expenses are not index like. After all expenses the expected return is currently about 8% with and SD based on historical data of under 5. Now if you can find a better investment, with less downside risk than congratulations. This IMO is the single best investment I've found in decades and IMO the spreads are likely to come down as capital rushes in, and yields more likely to fall to say 6% where they would still be attractive.

As I said, I've made a very significant personal investment and I don't get any compensation in any way from Stone Ridge, nor does any other RIA. So yes I think it's a wonderful opportunity and everyone I know who has experience in this field has agreed, and invested themselves.

I would add that I've also made a similar investment in their reinsurance fund SRRIX with an ER of 2.42%, and it's high because you are basically paying them to put you in reinsurance business without the balance sheet of a reinsurance (you don't those risks, just isolate the reinsurance risks). These type products have been available to hedge fund investors at fees more like 2/20 but now firms like Stone Ridge are bringing them to market at much lower, though not low fees. But here too management skill is what you are paying for and that means skill in getting exposure to beta, not trying to add alpha, buying entire slices of books of business.

And as to your last statement, about speculative, don't you think that is an SEC requirement on any investment that isn't plain vanilla. This is far safer than investments say in junk bonds. And there's decades of data on these type loans, as the banking industry has been originating them and the Fed has all the data.

[OT comment removed by moderator prudent]I think the point Stlutz raised about expense ratios is a valid one...we are bogleheads after all!

larryswedroe wrote:stlutz
And as to your last statement, about speculative, don't you think that is an SEC requirement on any investment that isn't plain vanilla. This is far safer than investments say in junk bonds.

[OT comment removed by moderator prudent]

I did some homework and the prospectus says :"In addition, the Fund may invest in securities that are rated below investment grade. Below-investment grade securities, which are often referred to as “junk,” have predominantly speculative characteristics with respect to the issuer’s capacity to pay interest and repay principal. They may also be difficult to value and illiquid."

So, if the prospectus says they invest in "junk", how can you say this is an investment far safer than junk bonds?

As to your question, all prospectuses are written in ways that avoids having to go back and get approvals every time some minor difference or exception is needed. So the legal teams put in all kinds of possibilities. I'm not aware of any such investments at this point. But here's an example of a possible one that could happen. Let's say that prepayments were much higher than expected and the fund was sitting on lots of cash until new originations could be generated. The fund might buy a ABS security with the same or similar characteristics. In fact the fund has rights to co participate in ABS of the platforms with which they work. Recently they sold off some loans and had a nice capital gain, that isn't anticipated in the expected returns I showed. That added I believe something like 1/2% in returns to the fund. I'm just guessing here but that's a possibility I could see. Then when loans are originated sell of the ABS.

Note the very short duration of the fund provides the benefit of a much better hedge against inflation risk while still earning the substantial credit premium, which has been well rewarded here, though not in investment grade bonds.

Finally, we estimate that in 2008 a fund of this kind would have experienced credit losses of about 7%, versus the 4% built into assumptions based on the historical data. That would have yielded about a breakeven result, about what banks earned on non subprime credits during this period. On other hand look at returns of junk bond funds, they were down like 50%. Think that makes the case.

Call me old school, but I find abbreviations for statements detrimental. Every time I see them (OMG is the only one that's finally became intuitive), I've got to read the letters, confirm it matches what I THINK it's saying, and then begin reading again. It really detracts from and breaks the rhythm (for me) what the poster is trying to say. In this case FWIW. It gives me enough pause (to confirm what I think it says), that it loses momentum, and to a certain degree, effect of what they're saying. But that's just me. OK, I've had my moment, let the conversation continue...

larryswedroe wrote:P2P lending should never be done by individuals IMO, way to much concentration risk and too much asymmetry in information.
Now with that said IMO it's an excellent asset class as alternative (not substitute) for safe fixed income. And I personally have a large investment in LENDX fund run by Stone Ridge. Basically you're paying them to run a P2P bank without all the infrastructure and regulatory regimes banks face, but one that still needs great credit people (note I was head of credit for the largest private mortgage company in country so I have lots of experience in this area), and not something individuals should be doing on their own IMO

Larry,
I was pitched on the LENDX fund and passed on it. Besides the relatively high fees, especially when you look at them as a fraction of the interest rates on the underlying loans, I did not like the limited liquidity provided.
I did like the exposure they offered to lenders other than Lending Club in the P2P space, such as SoFi.
Another issue which nagged me about it, is that I think it is essentially mispriced at NAV. This is because the loans are treated as all being at par until they are late or default. True pricing would take into account that at the outset, a certain number of loans are going to default, and should thus be priced at less than par. Thus, investors who withdraw funds are treated advantageously versus new investors.
At this point, as mentioned in other threads, I've let all my P2P investments run-off thankfully, with positive returns. Given the issues at Lending Club, which is arguably the most transparent and scrutinized platform given that they are public, I thought it prudent to see what happens through a full economic cycle. Bankruptcy risk of the platform companies are real, and each one is somewhat differently structured which will lead to different outcomes. This is actually an area that LENDX properly addressed as they only buy whole notes and not the fractions that individuals invest in.

larryswedroe wrote:Due to limitations on tax advantaged space it's relatively small amount, but I sold ALL by CDs to invest. Expected return about 8% currently with just 2 year duration. So traded some credit risk for much less duration risk and about a massive premium which is mostly uncorrelated to equity returns except during periods of high UE. And if you stick to the non subprime in even in a period like 2008 with double digit UE net returns were around zero. It's in the subprime that you get massive losses.

I could see say 25% of fixed income in this space in a well run fund, or say 10% of total. But could take from equity side and have above market returns expected with about 1/4 of the vol and much less tail risk, then would consider taking even more.

But fund should be highly diversified, even globally. This is all about good risk management cultures.

I've written a white paper for our clients as we are beginning to implement in portfolios, so I might publish a version on line without going into the details of the specific fund too much.

Larry

8% return with 2 year duration... sounds lovely! But sadly, I follow Buffett's rule of only investing in what I understand... and I do not understand a lot about Stone Ridge. Sad that, as I'd love returns like this.

I took a look at PatchofLand and Arixa Capital which seemed to offer similar returns but alas, although I understood them better (or at least PatchofLand better) it just seemed to good to be true. I find these things work how they're supposed to until I get on board. By that time it's too late to make the returns everyone else has.

I also worried that companies like StoneRidge and Arixa could end up like Madoff. How do we actually know they do what they say?

larryswedroe wrote:Due to limitations on tax advantaged space it's relatively small amount, but I sold ALL by CDs to invest. Expected return about 8% currently with just 2 year duration. So traded some credit risk for much less duration risk and about a massive premium which is mostly uncorrelated to equity returns except during periods of high UE. And if you stick to the non subprime in even in a period like 2008 with double digit UE net returns were around zero. It's in the subprime that you get massive losses.

I could see say 25% of fixed income in this space in a well run fund, or say 10% of total. But could take from equity side and have above market returns expected with about 1/4 of the vol and much less tail risk, then would consider taking even more.

But fund should be highly diversified, even globally. This is all about good risk management cultures.

I've written a white paper for our clients as we are beginning to implement in portfolios, so I might publish a version on line without going into the details of the specific fund too much.

Larry

8% return with 2 year duration... sounds lovely! But sadly, I follow Buffett's rule of only investing in what I understand... and I do not understand a lot about Stone Ridge. Sad that, as I'd love returns like this.

I took a look at PatchofLand and Arixa Capital which seemed to offer similar returns but alas, although I understood them better (or at least PatchofLand better) it just seemed to good to be true. I find these things work how they're supposed to until I get on board. By that time it's too late to make the returns everyone else has.

I also worried that companies like StoneRidge and Arixa could end up like Madoff. How do we actually know they do what they say?

I have to say I agree with you. If something requires a whitepaperit is too complicated for me.

i've always thought of p2p lending as very high risk, so seeing someone like larryswedroe championing it makes me think i have jumped to an improper conclusion. would love to see that white paper. although, i would probably not understand it. =(

I would be interested in how you got comfortable with Stone Ridges underwriting? I have done some level 3 marking in this area for hedge funds. What I have seen is rates of return 6 to 7% pre-expense ratios for a slice across credit grades. Most of the 13% rate of return loans I have seen are typically in the lower credit ranges. One big issue here IMO is there has not been a bad credit event for these types of products because they are new and I have seen is many lower credit credit card customers transfer their balances to these platforms.

Also there is alot of leveraged institutional money already in the market. Hedge funds and BDCs are already investing here. The securitization market has declined recently as some the credit criteria has changed once again for these platforms. Given this change I can see an opportunity but if it exists it is only a matter of time before it closes. I still think the biggest issue is the favorable credit environment over which any historical data is available.

Another investment for which you get similar returns which has bank level underwriting is a BDC named TPG Specialty Lending which is yielding 8.5%. You have a team of underwriters from a bank (Wells Fargo/Foothill) that has close to zero losses with a proprietary loan origination platform. The difference is you have a team that has been doing the underwriting on the same type of assets since the late 1990s with the same results. I worked with them over 10 years and they had the same great underwriting results. With these type of situations, I like to look at the fees as a % of income so if it is at or below 35% it is cheap compared to a typical bank efficiency ratio of 50%. So as you say the fees are not an issue if they can deliver the returns.

Second, they don't have same regulatory burdens nor infrastructure costs of banks (like the branches). They advertise on social media to get business. Much cheaper.

Third, They hire, the good ones anyway, the same top credit people who ran the big banks credit programs and use the same algorithmic credit scoring systems and now add big data available on social media to improve credit risks.

Fourth, so they with lower costs and superior service have a great model to ORIGINATE. The problem is on the bank end, finding the buyers. So the solution is to use institutional funding that provides persistently available and instantly available committed capital, allowing approved loans to be immediately funded, improving service greatly. Lending club went from about 85% retail funding last year to about 85% institutional this year. Likely will still see some retail funding as IMO the institutional money will stay away, or most of it, from the subprime stuff. I would. You cannot underwrite crap is the first lesson I was taught in credit training (you cannot collect enough interest to make up for unpaid principal).

Fifth, what institutions provide is all the due diligence you will never be able to do on the credit cultures of the lenders and provide the ongoing monitoring and the broad diversification that is critical. So my recommendation is to not do this on own. EVER. I'm trained in credit risk and was responsible for credit risk at the country's largest private mortgage lender, and I would not do it on my own.

BTW-the Fed loves this business as it is bringing new and cheaper sources of capital to consumers and businesses. Great for the country.

Boglephreak/Dottie
P2P isn't by its nature very risky. Depends of course on the quality of the loans one buys.
As to the white paper, it explains the business and the risks, and it's actually pretty simple. And despite what most people think, there's a ton of data available. Here are some examples of the research

Riza Emekter, Yanbin Tu, Benjamas Jirasakuldech and Min Lu contribute to the literature with their 2015 study, “Evaluating Credit Risk and Loan Performance in Online Peer-to-Peer (P2P) Lending,” which appears in Applied Economics. They analyzed the data from the Lending Club, one of the largest providers of peer-to-peer loans. The database consisted of more than 61,000 loans, totaling more than $700 million, originated by the Lending Club in the period from May 2007 to June 2012. Almost 70 percent of loans requested were related to credit card debt or debt consolidation. The next leading purpose for borrowing was to pay home mortgage debt or to remodel a home. The following is a summary of the authors’ findings:

• Borrowers with a high FICO score, high credit grade, low revolving line utilization, low debt-to-income ratio and who own a home are associated with low default risk. This finding was consistent with that reached by the authors of a 2012 study, “Trust and Credit: The Role of Appearance in Peer-to-Peer Lending,” which appeared in the August 2012 issue of The Review of Financial Studies.
• It’s important to screen out borrowers with low FICO scores, high revolving line utilization and high debt-to-income ratios, and to attract the highest-FICO-score borrowers in order to significantly reduce default risk. The higher interest rate charged for the riskier borrower is not significant enough to justify the higher default probability.

The authors found that in the case of the Lending Club, the majority of Lending Club borrowers (82 percent) had FICO scores between 660 and 749 (a score below 650 is considered low, a score between 650 and 750 is medium and above 750 is high) compared to 28 percent of the U.S. national average. About 80 percent of Lending Club borrowers fell into medium FICO score range, and they eliminate the one-third of borrowers who make up the riskiest population.

Note that the authors’ findings on credit risk are consistent with those of Zhiyong Li, Xiao Yao, Qing Wen and Wei Yang, authors of the March 2016 study “Prepayment and Default of Consumer Loans in Online Lending.” They too found that default can be accurately predicted by a range of variables. The authors noted that there is increased prepayment risk on these loans because the lenders don’t charge any early prepayment penalties. However, if the lender requires that all loans be fully amortizing, and none are long term (typically three- to five-year maturity), duration risk is relatively small. And, of course, loans that prepay have eliminated the risk of a later default.

Sperry
One of the important roles a good financial advisor plays is to provide the due diligence on investment products that you could never do on your own. We spent about two years doing due diligence on Stone Ridge, beginning with their reinsurance product, before we felt comfortable that we had a firm whose culture was consistent with ours (doing the right thing for clients). And one of the things we liked is that they, like us, put their money where their mouths are, investing significant dollars in their own products. And IMO they have assembled an incredibly strong team with very strong credit backgrounds. And they have rejected working with the vast majority of platforms they have looked at, around the globe. And they typically take about 6 months of performing due diligence (with entire teams of people being on site) before approving a platform. This is what you are paying them for. That's why it's not cheap like buying an index fund. And IMO it's a requirement for investing in this space. I don't necessarily want the cheapest fund as it's not a commodity here, as an index fund is.

I would note that to my knowledge there hasn't been any fraud with SEC regulated mutual funds and closed end, interval funds, like Stone Ridge's, are regulated just like mutual funds, by the SEC. I would add that their daily valuations are provided by outside sources, highly reputable firms, Duff and Phelps in this case, and are also audited by Ernst and Young.

rrppve
Passing of course is fine. But the only way to effectively run a fund that makes longer term commitments in illiquid assets like consumer and small business and student loans is to have committed capital. So here the fund is making 3-5 year loans to consumers and small businesses and even longer loans to students. So you MUST have limited liquidity, for which you are being paid a handsome liquidity premium by the way. That's why the yields are so high. It's not just the credit risk, where losses on prime loans have averaged about 4% historically. So if you don't need the liquidity this is exactly the type of product you should consider investing in because you are being paid a premium for a risk you don't have!!! It's like what the Yale's and the Harvard's have been doing for decades.

Consider that in an IRA and assuming you don't take more than your RMD, even at age 90 I don't think the RMD is 20%, and you can always get a minimum of 20% a year out. The SEC rules provide for that.

As to your assumptions about NAV. That is incorrect. They are not treated at par, they are bought at par. They are valued based on historical default levels and actual experience. So they know on origination that some will default and that is built into the valuations which is done, not by SR, but by Duff and Phelps. So there are expected loss default curves that are used to value and then monitor, seeing how the loans are performing, better or worse, than the model predicted. And that impacts valuations.

As to issues with Lending Club, they have since tightened their credit standards to be more in line with Stone Ridge's requirements, and SR will only buy loans that meet their requirements. No subprime.

As to bankruptcy risk. First, part of doing due diligence is checking the financial viability of your partner. And you are correct that one strong benefit of SR's program is they buy the loans and take possession of the documents while the originator services them for a fee. If the originator would go out of business SR has other servicers who would simply take over the servicing rights.

STlutz[OT comment removed by moderator prudent]

First, as I have already explained it makes no sense whatsover to consider the servicing fee of about 1% kept by the originator. That's just a dumb SEC rule. As I said if you bought the same exact loan in a security the expense would not be required to be shown. You are simply buying a NET interest payment. So that should not be there. Nor should the borrowing costs associated with the leverage. Yes it's a cost of the fund (but it's offset by the income earned with the invested leverage), but it's not the MANAGEMENT fee. There are only two fees that should be considered expenses truly borne by investors. The first part is the 1.5% management fee, along with the other 44bp. Then custodians, not Stone Ridge, charge 10bp to hold the funds as Stone Ridge doesn't pay for custodians fees. You often see this in mutual fund fees. So since this is a true cost to the investor it should be counted. So you get around 2%. And as I noted, that should be dropping over the course of the next year to about 1.85 total, 1.75 plus the .1. Now that isn't cheap, but as I noted you aren't investing in an index fund here. You are paying for basically someone to run a bank for you, without the branch infrastructure.

And your apples to apples is more like bricks to apples, as I explained above. There is no logic to having either the servicing fees nor the interest expense showed in the ER of the fund. At least not IMO. Yes the rest of the expenses should be counted, as that is what you are paying for.

The bottom line is that at today's levels of expected return of about 8% (after all fees and expenses and expected credit losses) with just a two year duration, this is equity like expected returns with IMO nowhere near the equity like risks (in 2008 banks were generally at least breaking even or making some money on prime loans of this type while stocks lost as much as 60%), or as alternative to intermediate bond fund (much higher yield, with much less inflation risk trading off some credit risk and giving up the liquidity, which should only do if are sure don't need it). And almost all investors have some assets that they know they will not have to access within this type of time frame.

I hope this is helpful
Larry

Last edited by larryswedroe on Sun Dec 04, 2016 10:52 am, edited 1 time in total.

Without going through all the math, you have average YIELD of about 14% on the portfolio of PRIME loans, less the servicing fee. So let's call it 13%. Take off 4% for expected losses that's about 9%. Then 2% for management fees and get about 7%. Then add bit back due to the benefit of the small amount of leverage and you get about 8%. Which I agree with you even given the liquidity premium you should get, looks too large given the 2 year duration. So IMO spreads likely to come down as capital flows in. Now the market is huge, multi trillion, so perhaps will take long time for that to happen. No one knows.

While I would prefer that spreads stay wide, if they do come down then current investors will pick up a nice capital gain. AS I have noted the fund has already participated in ABS sales and picked up some nice gains. And that isn't in my expected return calculation.

As to how we got comfortable with their underwriting. As I said, I have considerable personal experience and spent days grilling them with questions and had friends with far more and more diversified credit experience than I did grill them as well. And I can say this was the most impressive group I've met. They have very deep and highly experienced team that ran multi billion dollar credit books at some of the largest banks in world. Again that's why it's not cheap, you're paying for a lot of value add.

AS to not being an event. While technically that's true, we have data going way back on consumer and small business loans and certainly have the recent great financial crisis to look at. And see the note I wrote above on the research and losses. So there is plenty of data to look at.

Another benefit of this fund is that it's already global but with no currency risk, that's hedged.

I would note that to my knowledge there hasn't been any fraud with SEC regulated mutual funds and closed end, interval funds, like Stone Ridge's, are regulated just like mutual funds, by the SEC.

[OT comment removed by moderator prudent] As Larry notes, the rules around how various types of mutual funds operate have worked extraordinarily well. In case it wasn't clear before, I was not alleging that Stone Ridge are crooks. In my view they are clearly not.

Stone Ridge says this is speculative investment, not me. The section on risks of investing in the fund goes on for nearly 30 pages (the same section for Vanguard's Government Bond funds is 1 page). They are the ones running the fund, not me. Stone Ridge, not stlutz, says that the notes they hold are illiquid and therefore everybody can't take all of their money out immediately if the fund's share price unexpectedly goes down. Finally, Stone Ridge is very up front about the fees involved and that if there is alpha here, a not-insignificant portion of it will go to them. And if you are using an RIA to get access to opportunities like this, your advisor will also keep a portion of that alpha.

This fund is clearly targeted at high-net-worth individuals, not me. The money I have put into bank deposit products (e.g. savings accounts, CDs) is money I have determined I really can't afford to lose. An HNW individual may simply be using CDs as a temporary investment because it provided the best returns at the moment and not because of things like the FDIC guarantee. Again, Stone Ridge makes it very clear that this fund is not equivalent to CDs.

This fund isn't even available for investment to 99.8% of the population out there, so I don't need to go on and on. The primary advice I have for this thread is to always read the prospectus for the fund you are investing in, whether it's this fund or the funds that comprise Taylor's 3 fund portfolio. If the prospectus and the person selling you the fund are saying different things, go with the prospectus. That advice may not work 100% of the time, but am willing to say that it's appropriate at least 98% of the time.

As to your comments above, of course one should read a prospectus and be fully informed. That's true of every investment.

As to only being appropriate for high net individuals, IMO there is no basis for that at all. It's appropriate for any investor (with access) who can take the liquidity risk while noting that is is NOT a substitute for safe fixed income, it is a very good alternative for those willing to accept the credit risk, while at same time reducing significantly term and inflation risk (while earning a large liquidity and credit premium). And for those who use it as alternative to equities, it's a lot less risky IMO, not even in same ball park. The expected SD is under 5, while equities it's about 20.

As to use of term speculative, that's just legalese, and this is no more speculative and far less risky than say equities as I noted above. There are clear reasons to expect a higher return and a lot of data to back that up, as I showed. Speculation implies taking risks which are not compensated for with higher expected returns and/or risks that can be diversified away. This fund owns hundreds of thousands of loans across countries even. So it's far from what the term speculative implies, as opposed to legalese required in a prospectus.

Also there is NO ALPHA at here at all. They are seeking BETA, not alpha, or exposure to a factor, or a unique source of risk and buying "the market" if you will for the type of credit quality they want exposure to (no subprime). And the fees IMO are commensurate with the value added they are bringing which is high in and important area. The issue is after fees what's the risk and return to investors. Now if you can show an 8% expected return with these type of risk characteristics I would love to see it. If I had more room in my tax advantaged accounts I would have at least doubled my investment in the fund.

And finally if you know anything about prospectus's then you would know that they say all kinds of things the fund is highly likely to never engage in (try reading some of DFA's for example). It's all about never having to go back and get shareholder approval to do something that wasn't explained already in the prospectus.

Clearly there are risks and among them is liquidity. And thus one should not invest unless one is as certain as they can be that they won't need it. Of course most people have some portion of their portfolios that they know they won't need liquidity for, like in their IRAs, where this should be held.

I think the liquidity risk just isn't worth it IMHO. When Harvard and Yale take it, they are usually looking at long-term vehicles with expected returns >20%. The underlying investments have multi-year time horizons and the funds they are investing in are not perpetual. They have defined lifetimes and shorter defined investment horizons. My view is based on the world of private equity and VC funds.
Here you're looking at an investment with expected returns of 8%. The fund is the first I know of in this asset class. If something goes wrong with the fund or one of the major lenders that they are providing capital to, you have no ability to react. No way to stem the losses.
One of the lessons learned from the recent Lending Club crisis is that not only did new capital dry up, but the secondary market also froze. You were not able to sell individual loans on the secondary market. In addition, unlike LC's premise that institutional capital was more stable, what they found was that institutional capital dried up all at once. Thus, they renewed commitment to the individual investor as they sought capital to keep making loans, in addition to raising their rates. Institutional capital had more of a herd effect than individual. I think there will be more scandals in P2P, especially among the accredited investor only platforms. Granted that SR's due diligence should hopefully lower their exposure to them, but who knows. They doubled down on LC after their scandal.
Now with regards to the pricing of LENDX, I'm sure you did more diligence than I, but I'd suggest you look at the LC event more closely. Since LC had to offer yield bonuses to keep the capital flowing, that essentially meant rates rose for this particular asset class. Thus, the existing LC loans on the books of LENDX should have all been discounted and impacted LENDX's NAV. I don't know whether this happened or not or on what time scale. NAV is set daily, but I'm sure Duff & Phelps doesn't do a deep dive on the portfolio on a daily basis.
Still a pass for me.

rrppve
Well certainly entitled to opinion but let me offer different perspective

First re liquidity and endowments. The concept is the same but the kind of returns you are talking about are for investments with dramatically higher risks, not just liquidity which is much longer term liquidity risk, but much higher SDs, like 100% for VC in some cases. Here we are talking like an SD of about 5.

Second, it's not the only vehicle of it's kind, there are already several others including River North and Colchis and you can bet that there will shortly be others

As to ability to react, here are the big risks that I see. The originators go bankrupt. Not an issue as Stone Ridge owns the loans and has the documents. They simply replace the originator with another servicer, and they have about 8. So that's not an issue. The other big potential risk I see is small in probability but possible is that there are regulatory reasons that shut originators down. The fund would then simply unwind, letting assets run off. No risk to investors, except possible reinvestment risk at that time. The issue of secondary market is irrelevant to the fund basically. Though it does provide an outlet with potential ADDED benefits as I outlined above, unexpected K gains from sales. Note also the fact that the secondary market drying up is one reason why the originators need the institutional investors to always be there as partners. They don't have a viable business model without them.

Note re Stone Ridge, they began doing business with Lending Club AFTER the quote scandals and after they tightened credit policy. But also note one of the things I like is that the fund already buys from multiple platforms and not just in US, but also in US, Australia and New Zealand, diversifying economic risks and business risks as well. And at least IMO this phenomenon of P2P lending will spread quickly so that shortly will be worldwide, further reducing concentration risk. Note SR also monitors every single loan originated and monitors performance against expected loss curves. Again, that's what you are paying the relatively high fees for.

BTW-River North bit cheaper at this point but this isn't a commodity, and it's value added, not fees alone that matter.

Also if the loans were performing worse than the loss curves expected that would show up in current NAV.

With all that said, it's personal decision, hopefully my comments have helped you

I find the discussion in this thread interesting, but I find the irony involved equally so.

As far as I can tell from Larry's posts in this thread, these loans are essentially unsecured loans offered to individuals and small businesses with FICO scores that would generally be described as "fair" or maybe even "good". Checking bankrate.com, they offer categories of: debt consolidation, home improvement (pool, solar, renovation), auto, medical, wedding, and recreation (boat, RV and timeshare). "Live below your means" (including an emergency fund) represents the lifestyle for most of the people on this forum, regardless of income, and yet none of these loans would exist if it wasn't for the millions in the US end elsewhere who choose not to do so.

Last edited by Ethelred on Sun Dec 04, 2016 3:10 pm, edited 1 time in total.

Larry,
Thanks for the perspective. Here is what Stone Ridge told me about the LC scandal.
LC was an approved lender for their fund. They were funding loans at LC. When the scandal hit, they put a hold on further LC investments. They then flew a team to meet with LC for 1-2 days. They removed the hold and put more capital into LC loans and viewed the yield bonus as a nice sweetener.
I do find the asset class interesting, but as I've said am not currently investing in the space and will reconsider after seeing what happens after completion of an economic cycle.

Thanks for the response. My biggest question is where are they finding 14% lenders with high credit scores? If you look at Prosper's site, for that type of expected return you are talking about HR or E loans, really risky stuff: https://www.prosper.com/invest. They may have some secret sauce but I would be skeptical. This market already has levered institutions playing here so any unsophisticated buyer premium is gone. The WA expected returns for Prosper are closer to 6.85% and if you want the less risky ones you are talking 3 to 5%. I also noticed that a large portion of the income is rebate income. What is this? Also from the latest Semi-annual report the expected loss ratio is closer to 6% per level 3 valuation assumptions. These are just estimates today. In my experience with the P-to-P space is there is slippage of a percentage point or two due the difference between the original model and the actual losses (from 2015 to date). So if you subtract these from your estimated 8% you are at 5% pretty quick & closer to what you could get from the typical P-to-P. I would rather go with an 8.5% from TPG Specialty a group that has proven track record over the past 15 years.

Packer,
Here's an example, I've never had a late payment to a credit card in my life. Note once. I recently got a notice from my card provider raising my rate from 21 to 23%. Now irrelevant to me. But for those with relatively high FICO scores a 14% rate for fully amortizing loan is a lot better than 20%+.

With advent of Dodd Frank about 25% of the small banks have already closed, and they make virtually all the small business loans. So credit has become very restricted to small businesses. So many have turned to floating their business on their credit cards. And rates here again are lower and service much higher.

And on student loans actually the rates are lower and the credit quality higher. Reason is government makes loans to all at the same rate, so the good credits subsidize the bad ones. Companies like SOFI provide loans to the best credits at lower rates. If memory serves all scores are above 700, many much higher, with average about 770. Their consumer loans have average score about 730.

These are the same loans, only not revolving credits, that banks have been making for decades with large profits, when they avoid the subprime space.

As I said, there are no what are called subprime loans in the portfolio.

Interesting scenario. Do you know how much margin of safety they have in their loan models which are currently assuming an about 5.75% loss rate? You had mentioned 4% in your previous post. Is that management's current expected loss rate? Thanks.

Without going through all the math, you have average YIELD of about 14% on the portfolio of PRIME loans, less the servicing fee. So let's call it 13%. Take off 4% for expected losses that's about 9%. Then 2% for management fees and get about 7%. Then add bit back due to the benefit of the small amount of leverage and you get about 8%. Which I agree with you even given the liquidity premium you should get, looks too large given the 2 year duration. So IMO spreads likely to come down as capital flows in. Now the market is huge, multi trillion, so perhaps will take long time for that to happen. No one knows.

While I would prefer that spreads stay wide, if they do come down then current investors will pick up a nice capital gain. AS I have noted the fund has already participated in ABS sales and picked up some nice gains. And that isn't in my expected return calculation.

As to how we got comfortable with their underwriting. As I said, I have considerable personal experience and spent days grilling them with questions and had friends with far more and more diversified credit experience than I did grill them as well. And I can say this was the most impressive group I've met. They have very deep and highly experienced team that ran multi billion dollar credit books at some of the largest banks in world. Again that's why it's not cheap, you're paying for a lot of value add.

AS to not being an event. While technically that's true, we have data going way back on consumer and small business loans and certainly have the recent great financial crisis to look at. And see the note I wrote above on the research and losses. So there is plenty of data to look at.

Another benefit of this fund is that it's already global but with no currency risk, that's hedged.

Hope that helps
Larry

Larry,

I'm interested in this fund and trying to learn as much as possible. I have a few questions if you have time to respond:

You mentioned that there are no sub-prime loans in the portfolio. Did I understand you correctly?

You mentioned that the fund is global with ?USD hedging. How global is global? Are fund holders holding loans in developed markets, emerging markets and frontier markets?

In his blog he mentions a newly identified questionable practice (separate from the improper handling of loans that resulted in their CEO resigning). The Bloomberg article discusses additional questionable practices by former CEO and other Lending Club insiders. To quote MMM:

"August 2016 Update: This Bloomberg article revealed some more questionable history in the company: [bold and italics mine] back in 2009, the former CEO and other insiders took out some unneeded loans and rapidly repaid them to juice the company’s early results to impress investors. There were other allegations regarding individuals taking out multiple loans to cheat the risk ratings system, but I feel that this response by the new CEO Scott Sanborn addressed that properly, unless further information comes in."

When Stone Bridge was performing their due diligence did this come up? And, I ask respectfully, if not, should it have come up? How do questionable business practices on the part of senior management affect the credit worthiness of the recipients of P2P lending and the purchasers of their debt? More plainly- how at risk is my capital if Lending Club senior management or any other P2P lender games the system?

I want to like this product, but as in all things I want to understand it as much as possible. It may sound like I'm pessimistic, but quite the contrary- I'd like to own it.

Also, how is this product different from a bank loans (floating rate fund) product or a "better" predominantly BB or B non-investment grade mutual fund like Vanguard's VWEHX? Its seems as if you're saying that in times of liquidity crisis the junk bonds, floating rate funds and equities will tank, but individual P2P loans tend to be repaid. Is this true? Intuitively, you'd think that all would suffer.

Respectfully,

GOR

"The greatest enemies of the equity investor are expenses and emotions." -John C. Bogle, Little Book of Common Sense Investing. |
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"Winter is coming." Lord Eddard Stark.

Packer, yes expected losses are about 4%, and that's based on lots of data for loans of this type quality. Also keep in mind that most business loans are either secured or have personal guarantees, or both, and they make up about 50% of portfolio. Also on most consumer loans they have a priority, though unsecuritized. This is achieved by offering a discounted rate if you sign up for automatic debit of payments. So unlike credit cards where consumers have priorities, this is priority debt, though still unsecured of course. But that clearly lowers risks

I think a typical portfolio of originations might look like say roughly 30% A, 20% B, 15% C, >10% each D+ E, and <10% F&G, which has score of 660. They allow small percentage of loans, less than 5% I believe, for credits with bit lower score but have high incomes.

GreatOdinsRaven
First, the fund is currently diversified across about 8-9 platforms. That reduces risks from several perspectives.
Second, yes no subprime, below 600 scores. That's where the big losses are.
Third, currently in US, UK, Australia and NZ, and no currency risk.
Fourth, currently there are less than handful of loans in default, to my knowledge, but that's not meaningful as losses increase over time and fund only began life in June. But losses are in line with expected loss curves.
Fifth, to my knowledge what happened at Lending club didn't impact loan quality and at any rate Stone Ridge sets its own criteria, only buys loans that meet that criteria and also requires that originators buy back any fraudalent loans, so capital capacity clearly part of the process. If memory serves Lending club has over $200mm in capital currently. Also Lending club has tightened standards as all of the originators who work with institutional providers have as when this happened they got cut off, and they cannot have that. When controls were improved lenders came back, and note credit standards were tightened. Of course this doesn't eliminate fraud. But again SR at least requires the originator to buy back fraudalent loans.

As to floating rate loans, that's business loans to large businesses generally, not small business like these. What I can tell you is that junk bonds lost about 50% in 2008, and high yield like Vanguard about 25%, and consumer/small business lending of this quality about broke even to my knowledge.

Let me just add. I have no "skin" in this issue in terms of whether others invest or not. In fact I would prefer not, so spreads stay wide (:-)). My only skin is my own money invested. So I've put my money "where my mouth is" so to speak. I don't recommend things I would not be prepared to invest in. Just trying to help others become aware of what I think is a good investment. That's it. I have no relationship other than as a client with Stone Ridge, or any other fund provider for that matter.

enki wrote:I know this doesn't answer your question, but personally P2P Lending is dead to me. Granted I only put a small amount of money in to test the waters, but the results and experience has been sub-par to say the least. For the last two years, I think I barely broke even when factoring in my 30% default rate (with B and C loans). I know the pro-P2P people say you need to just invest more to see a better return, but sorry -- that just doesn't make sense to me.

I have two big issues with the way things work. The first is that even though I have had MANY late payers, including some loans that have paid late 10+ times, Lending Club has NEVER charged a late fee. Ever. Their documentation promises it as a way to recoup loss. And of course they levy a late fee on me. But when I challenged them on this, they said they often (always) waive the fee for the lendee to help encourage them to pay their monthly payment and they aren't obligated to enforce it. Even when payments were received 2-3 months late, there was still no fee applied. Sorry, but that just pisses me off.

The second, and obviously bigger concern, is that the ways these systems are structured means that if the lending company goes under, which is not an impossible situation, we have no equity in the notes that were issued and our investments are worth pretty much nothing. Which is why it boggles my mind that people would use anything but play money in this platform (for example, I would never consider opening up an IRA with them).

I've read a lot of reviews and there were many positive ones -- but most of those are quite old and from when these companies first came around.

But that's just my experience and opinion.

I have been investing in Lending Club for several years. I am happy with it and continue to increase my investment there. I handle my own loans and do not "automate". I would continue for Half the return I currently receive.

LC usually doesn't charge the late fee if they can get the borrower to pay and get current. I am averaging less than 2.5% defaults, while LC predicts 3%.

larryswedroe wrote:
Let me just add. I have no "skin" in this issue in terms of whether others invest or not. In fact I would prefer not, so spreads stay wide (:-)). My only skin is my own money invested. So I've put my money "where my mouth is" so to speak. I don't recommend things I would not be prepared to invest in. Just trying to help others become aware of what I think is a good investment. That's it. I have no relationship other than as a client with Stone Ridge, or any other fund provider for that matter.

Hope this is helpful
Larry

Thanks for adding this part. I was wondering why you were discussing this in detail... but I believe you and as such find it quite helpful that you are letting us know of an opportunity you believe offers good returns with moderate risk. Still too risky for me personally. You stated the fund started in June (too short of a time period to assess) and as I mentioned upthread I have trouble understanding this in enough detail to make me comfortable. Yes, if I had a trusted financial adviser who I worked with for years it might open up my desire to get in - but thanks to bogleheads I've saved those fees and manage my monies myself. So I have to stick with easier things than this, which perhaps means I give up some yield, but at least I sleep comfortably. Sad that. Hate seeing my 1.25% APY on laddered CDs when there appears 8% returns available if only my brain could wrap itself around this stuff.

First you should not invest in something you don't understand, as all risky assets will go through some long difficult periods, or at least that's possible.

Second, with that in mind, this is really a simple product, though one fraught with risk if don't have the right credit culture. That's the key. It's basically the same business banks have made huge profits on for decades. And now thanks to the disintermediation of the P2P platforms the end loans are now available to individual investors, not just sitting on bank balance sheets.

To me the key is that you need an intermediary who has a very strong credit culture to protect you. As I said, I ran the credit for the largest private mortgage company in the US (we were neck and neck with Countrywide) and I can proudly say that to my knowledge not one single investor in the investment grade bonds we sold ever lost a penny due to default losses. And with that I would never do this on my own. IMO this is not a commodity product where you look for the cheapest provider as you would with a pure index fund. This is very different.

What would be the cheapest way to access this fund? I need to do more research regarding whether it would be right for my situation, but if I can't access anyhow, may as well save the research time. My 401k is through Fidelity and it does not appear I can access this fund through my brokeragelink account, as I can some of the AQR funds.

Slick
For better or worse Stone Ridge funds only available through approved RIAs
There are other products like River North that don't have that requirement, and it's bit cheaper. Might check them out.
Larry

I was an early adopter in LC when they arrived on the scene. Back in the good old days, individual investors had access to a large number of high quality loans. My two accounts (one taxable, one SIMPLE IRA) averaged around 10%, after fees and write-offs. Once the big fish came into the pond, just about all of the high quality loans got eaten up before individual investors had a chance at them. I have not added any new funds to either account in several years, and am just waiting for all the loans to pay out before closing my accounts. IMHO, the risk/reward ratio is unfavorable to the little guy at this point in time, and I don't expect that to change in the future.

I think you will find LENDX difficult to access without an RIA. Since they are interval funds with significant redemption restrictions, only 5% per quarter with advance notice, I sincerely doubt that any discount broker will let you invest without going through an advisor.